Competitive Devaluation

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DEFINITION of 'Competitive Devaluation'

A series of sudden currency depreciations that nations may resort to in tit-for-tat moves to gain an edge in international export markets. Competitive devaluation refers to a scenario in which an abrupt national currency devaluation by one nation is matched by a currency devaluation of another, especially if they both have managed exchange-rate regimes rather than floating exchange rates determined by market forces. Competitive devaluation is considered a “beggar-thy-neighbor” type of economic policy, since it amounts to a nation trying to gain an economic advantage without consideration for the ill-effects it may have on other countries.

INVESTOPEDIA EXPLAINS 'Competitive Devaluation'

The act of currency devaluation or depreciation improves a nation’s export competitiveness because it lowers the cost of goods exported from that nation for overseas buyers. For example, when the exchange rate is EUR 1 = $1.40, assume a European exporter sells a product in the U.S. at $10, which is equivalent to about EUR 7.14. If the EUR subsequently falls to 1.25, the exporter can slash the price of the product to $9 and still receive the equivalent of EUR 7.20 because each dollar now fetches more euros.

Currency devaluation also has a positive impact on a nation’s trade deficit because it makes imports more expensive. This forces domestic consumers to look for local alternatives to imported products, which provides a boost to domestic industry. This combination of export-led growth and increased domestic demand usually contributes to higher employment and faster economic growth.

The negative aspect of currency devaluation is that it may lower productivity, since imports of capital equipment and machinery may become too expensive. As well, devaluation significantly reduces the overseas purchasing power of a nation’s citizens.

Competitive devaluation is viewed as being harmful or deleterious to the global economy, because it may set off a round of currency wars that may have unforeseen adverse consequences, such as increased protectionism and trade barriers. At the very least, competitive devaluation may lead to greater currency volatility and higher hedging costs for importers and exporters, which may impede a higher level of international trade.